E4-1B – Activity Based Costing

Celia Inc. has two types of handbags: standard and custom. The controller has
decided to use a plantwide overhead rate based on direct labor costs. The
president has heard of activity-based costing and wants to see how the results
would differ if this system were used. Two activity cost pools were developed:
machining and machine setup. Presented below is information related to the
company’s operations.

Standard Custom
Direct labor cost 60,000 120,000
Machine hours 1,500 1,500
Setup hours 100 500

Total estimated overhead costs are _$342,000__. Overhead cost allocated to

the machining activity cost pool is __$222,000__, and __$120,000_ is allocated
to the machine setup activity cost pool.
Instructions
(a) Compute the overhead rate using the traditional (plantwide) approach.
Estimated overhead / Direct labor costs = Predetermined overhead rate
$342,000 / ($60,000 + $120,000) = 190% of direct labor cost

(b) Compute the overhead rates using the activity-based costing approach.
Activity cost Estimated Expected use of Activity-based
pools Overhead cost drivers per overhead rates
activity
Machining $222,000 Machine hours $74 per machine
3000 hour
Machine setup 120,000 Set up hours 600 $200 per setup
hour
Total $342,000
(c) Determine the difference in allocation between the two approaches.
Traditional costing
1. Standard: $60,000 x 190% = $114,000
2. Custom: $120,000 x 190% = $228,000
Activity based costing
1. Standard: 1,500 x $74 + 100 x $200 = $131,000
2. Custom: 1,500 x $74 + 500 x $200 = $211,000
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